Creditor Rights And Relationship Banking: Evidence From A Policy Experiment

Author(s) Gursharan Bhue, Nagpurnanand Prabhala, Prasanna Tantri

ABSTRACT

We examine how creditor rights shape the choice between arms length and relationship banking, exploiting natural variation due to changes in law. We show that arms length lending increases after a 2002 law that significantly expands creditor rights in India. The results are stronger when banks that enjoy greater informational advantage, for small firms, non-group firms and lenders empowered under the law. The results are confirmed by placebo tests and external validation tests using staggered implementation of an earlier, though weaker, law. Creditor rights determine not only the quantity but also the type of credit in an economy.